Chapter 9

December 12, 2013

A few months ago, Detroit, MI, became the largest US city to file for bankruptcy protection. In a potentially far-reaching decision, US Bankruptcy Court Judge Steven Rhodes has ruled that Detroit can proceed with its chapter 9 federal bankruptcy court proceeding.

The implication from this ruling is that the city’s existing pension plans and employee benefits are subject to modification, and this ruling is likely to reverberate in other cities that are also struggling with expenses that exceed their ability to remain solvent. Even for those still able to make their benefit contributions, they have often been made by having to slash expenditures for public schools, police and fire departments, and other key services.

Many once thought that under existing state laws, pensions were non-touchable in any bankruptcy proceeding. Judge Rhodes expressly ruled otherwise, stating that even though those pensions have protections under the Michigan Constitution, “Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy”.

This was the first time that a federal bankruptcy judge expressly ruled on this issue, so other cities are carefully watching the results of the appeals of this decision. In reviewing the financial crisis that caused this chapter 9 bankruptcy filing, Mayor David Bing acknowledged that the city had $18 Billion of debt, half of which was owed to lenders, and half of which was owed to unfunded pension and health care benefits for present and former city employees. If the case proceeds in bankruptcy, as expected, the court must decide whose debts are going to be slashed, and the end result may include the sale of some of Detroit’s assets, including its automobile collection and art works in its museums.

It appears clear that there will be unpleasant news for many Detroit residents in the coming months.